Report No. 1099a-MAG

Madagascar: Economic Memorandum on CurrentEconomic Position and Prospects and SelectedDevelopment IssuesDecember 20, 1976

Eastern Africa Country Programs II

FOR OGFICOAL USE ONLY

Document of the World Bank

This document has a restricted distribution and may be used by recipientsonly in the performance of their official duties. Its contents may nototherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

1970 US$1.00 - FMG 277.71FMG 1 - US$0.0036

1971 US$1.00 - FMG 277.03FMG 1 - US$0.0036

1972 US$1.00 - FMG 252.21FMG 1 - US$0.0040

1973 US$1.00 - FMG 222.70FlMG 1 - US$0.0045

1974 US$1.00 - FMG 240.50FlMG 1 - US$0.0042

1975 US$1.00 - FMG 214.32FMG 1 - US$0.0047

Fiscal Year

January 1 to December 31

FOR OFFICIAL USE ONLY

Foreward

This report is based on the findings of a missionto Madagascar in October/November, 1975 consisting ofMr. P. Landell-Mills (Chief of Mission), and Messrs. L. Currat(industrial economist), F. Gamble (educator), M. Purvis (agri-cultural economist), J.F. Rischard (general economist),G. Schreiber (national accounts economist), G. Sciolli (publicfinance economist)'. The draft report was discussed with theGovernment in August, 1976 and it has been subsequently updatedand revised.

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be discklsed without World Bank authorztion.

MADAGASCAR

ECONOMIC MEMORANDUM ON THE

CURRENT ECONOMIC POSITION AND PROSPECTS

AND SELECTED DEVELOPMENT ISSUES

TABLE OF CONTENTS

Page No.

MAP

BASIC DATA

SUMMARY AND CONCLUSIONS ........................... i - vi

I. INTRODUCTION ......................................... I

Background .......... ............................................. 1

The Plan and the Charter ............... ... 1......

II. PRODUCTION AND INCOME ........... ..................... 4

Overall Growth .................................. 4

Uses of Resources ................................... 7

Prices ....... .................. 8

III. PUBLIC FINANCE ...... ................................. 11

Overview ........................................ 11

Current Expenditure ..... ........................ 12

Current Revenue ..... ............................ 14

Central Government Investmentand its Financing ..... ........................ 16

The 1976 Budget ................................. 17

IV. MONEY, CREDIT AND THE BALANCE OF PAYMENTS ............ 18

Money and Credit . ...... .............................*. 18Balance of Payments ............. .. .............. 21

V. MAIN ISSUES ................................ .......... 25

Agricultural Planning ........................... 26

The Parastatal Sector ........................... 28

Industrial Development ..... ..................... 29

Manpower .......................... ........... . 30

Statistics ......PECTS......................... 31

VI. FUTURE PROSPECTS ...................................................... 32

TABLE OF CONTENTS (Continued)

VII. ANNEXES

Annex I - Agriculture: Recent Developmentsand Prospects

Annex II - Manufacturing: Past Performanceand Future Prospects

Annex III - The Parastatal Sector

Annex IV - Human Resources' Planning

Annex V - Statistical Tables

IBRD 10331FEBRUARY 1973

MALAGASY REPUBLIC f 0-SUAREZ

POPULATION DISTRIBUTION - 1971 dosumo Each dot represents 2,000 inhabitants Hell-VIIe,

* Over 60,000 Inhabitonts* 20000 - 60,000 Inhabitonts ao l0,000 - 20,00 Inhabitonts

* . ~~~~~~~AntaIahOW

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RO. JFI 1 2 7 lOft

DEFINITIONS OF SOC10L VOittATFlRO

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Page 3 of 4 pages

ECONOMIC INDICATORS

GROSS NATIONAL PRODUCT IN 1974 ANNUAL RATE OF GROWTH i%] constant prices)

US$ Mln. % 1966 -70 1970 -72 1972-197L

GNP at Market Prices 1532.2 100.0 5.5 1.7 0.4Gross Domestic Investment 223.7 14.6 7.4 - 4.6 5.9Gross National Saving L/ 171.7 11.2 24.8 -10.0 24.1Current Account Balance - 52.1 - 2Exports of Goods, NFS 288.6 18.8 1.8 - 0.6 - 5.9Imports of Goods, NFS 3149.7 22.8 -1.1 2.2 -14.4

OUTPUT, LABOR FORCE ANDPRODUCTIVITY IN 197L

Value Added?v Labor Force'/ V. A. Per WorkerUS$ Mln. % Mln. % US T %

Agriculture 653.6 41.8 3.51 82.8 186 50.4Industry 277.3 17.8 0.24 5.7 11146 310.6Services 576.3 36 9 0.48 11.14 (134 (353.4Unallocated 54.9 3.v - - 130 35

Total/Average 1562.2 100.0 4.23 100.0 369 100.0

GOVERNMENT FINANCECentral Government

(Eg_bill.) % Of _ DP1m7: 197h 1970-72

Current Receipts 49.4 13.1 15.8Current Expenditure 43.0 11.4 12.7Current Surplus 6.4 1.7 2.9Capital Expenditures 13.3 3.5 6.8External Assistance (net) 3.3 0.9 1.2

MONEY, CREDIT and PRICES 1970 1971 1973 1974 19751lllon FMG outstanding end period)

Money and Quasi Money 55.2 58.5 65.4 67.8 81.2 82.3Bank credit to Public Sector (net) - 7.9 - 9.1 - 2.7 - 4.2 5.0 12.6Bank Credit to Private Sector 52.8 59.7 59.5 59.8 70.0 72.5

(Percentages or Index Numbers)

Money and Quasi Money as % of GDP 22.1 21.8 23.9 22.6 21.6 20.5GDP Deflator (1970 - 100) 100.0 103.9 106.6 119.4 147.3 155.1

Annual percentage changes insGDP Deflator .. 3.5 3.0 12.0 23.4 5.3

Bank credit to Public Sector (net) -102.6 -14.4 70.6 -59.1 116.8 154.1Bank credit to Private Sector 17.3 13.0 - 0.3 0.5 17.1 3.5

NOTEt All conversions to dollars in this table are at the average exchange rate prevailing during the periodcovered.

1/ Including current transfers from abroad.

2/ At market prices.

/ Total labor force; unemployed are allocated to sector of their normal occupation. "UnallQcated" consistsmainly of unemployed workers seeking their first job.

2 Import duties.

not availablenot applicable

Page 1!ofb pages

TRADE PAYMENTS AND CAPITAL FLOWS

BALANCE OF PAYMESTS MERCHANDISE EXPORTS (AVERAGE 1972-74

1972 1973 197h US $ Mln 7/(Millions US $)

Coffee 56.9 25.0Exports of Goods, NFS 229.7 2b5.5 288.6 Vanilla 14.6 7.2Imports of Goods, NFS 262.2 279.8 3U9.8 Cloves & clove oil 22.ii 11.3Resource Gap (deficit =-) - 5 - 3C 3 -61.2 Meat & meat products 18.6

Fish & shell fish 10.5 5.2Interest Payments (net) 2.1 2.0 3.6 Sugar 6.7 3.3Workers' Remittances - 29.3 - 22.9 -22.5 Petroleum products 13.L 6.6Other Factor Payments (net) - 12.7 - 8.2 -11.1 Chromite L.2 2.1Net Transfers 36.5 33.1 39.0 All other commodities 55.o 27.3Balance on Current Account - 359 - -7TI Total 203.L 100.0

Direct Foreign Investment 21.9 15.3 9.8 EXTERNAL DEBT, DECEMBER 31, 1)/5Net MLT Borrowing

Disbursements 12.2 26.2 23.1 US $ MlnAmortization 6.2 8.8 6.3Subtotal 6.0 17.b 16.8 Public Debt, incl. guaranteed 167.9

Capital Grants 13.3 3.8 1.X8 Non-Guaranteed Private Debt *-Other Capital (net) L.8 157 -12 Total outstanding & Disbursed 167.9Other items n.e.i 3 - I 1/Increase in Reserves (+) 6.3 10.8 -36.1 DEBT SERVICE RATIO for 197hr

Gross Reserves (end year)V/ 52.2 67.) '.L Net Reserves (end year)2/ 50.7 67.L 3L.9 Public Debt, incl. guaranteed 3.3

Non-Guaranteed Private DebtTotal outstanding & Disbursed 3.3

Imports of crude petroleum 12.2 lb.) bL.7

RATE OF EXCHANGE

US$ 1.00 FMG 1.00 IBRD/IDA LENDING, (Nov. 30 ,19?f) (Million US $)= FMG =US$

IBRD IDA1272 252.21 0.00b01)73 222.70 0.0015 Outstanding & Disbursed 25.83 6h.50197 2L0.50 O.00b2 Undisbursed 6.75 47.601975 21L.32 0.00o7 Outstanding incl. Undisbursed 32.o 114.10

1/ Ratio of Debt Service to Exports of Goods and Non-Factor Services.

2/ Central Bank only

not available

not applicable

20 December, 1976

SUMMARY AND CONCLUSIONS

i. Over the past four years Madagascar has passed through a testingperiod of transition from which it has emerged apparently strengthened.Although the country gained independence in 1960, links with France remainedvery strong until 1972. In that year General Ramanantsoa replaced PhilbertTsiranana as President; fundamental reforms were initiated and the Coopera-tion Agreements with France were substantially revised. In January 1975General Ramanantsoa resigned and Madagascar subsequently experienced a phaseof political uncertainty, which ended with the appointment of CommanderRatsiraka as President in June 1975. A referendum held in December 1975resulted in an overwhelming vote in favor of a new constitution based on astrong presidential system and confirmed President Ratsiraka as Head ofState.

ii. The basic political orientation of the new Government has beenset out by President Ratsiraka in the Charter of the Malagasy SocialistRevolution. Major institutional and policy changes aim at placing controlof the economy in the hands of the Malagasy, promoting social justice andfostering local democracy.

iii. Greater Malagasy participation in commerce and industry is beingachieved by a substantial increase in public enterprise. The commercialbanks, insurance companies and a number of other key businesses previously inforeign ownership have been nationalized, and it is intended that the Stateshould become a majority shareholder in all enterprises of national importance.Foreign private investment is to continue to play an important role, beingregarded as a source not only of capital but also of technical expertise.

iv. To correct inequalities between different regions, investment isto be channeled to the least favored areas and as many government activitiesas practicable are to be decentralized. A radical reform of the educationalsystem is planned; all children of school age are to be enrolled in a five-year program of basic education with a curriculum adapted to the needs ofeach region. This ambitious reform calls for an additional million primaryschool places to be created by 1979.

v. The Charter makes the reform of local government a central featureof the new development strategy. The traditional village council, or"fokonolona", is being adapted to enable villagers to participate activelyin improving local conditions. The fokonolona are to undertake the marketingof crops, the retailing of essential commodities and the channeling of credit.They have begun to collect levies on the sale of produce and to use theproceeds to finance schools and other services. A hierarchy of newinstitutions based on the fokonolona is to be created to replace the existingsystem of local government.

- ii -

vi. Between 1966 and 1971, GDP in real terms rose by about five percentper annum, while the investment rate was at or above 15 percent. Following thechange in Government in 1972, a comprehensive reappraisal of economic policieswas undertaken. The major institutional reform of the economy has beenaccompanied inevitably by initial management problems. These, combined withthe recession in the world economy, have had an adverse impact on overalleconomic trends. In 1975, real GNP (in market prices) was still slightlybelow the level reached in 1971, after two years of decline in 1972 and 1973and a very slow recovery in the two following years. Per capita income in1975 is estimated at about US$195 (in current prices). Gross fixed capitalformation, having reached a peak in 1971, fell sharply (by 18 percent) in thenext year and has grown by only 1.5 percent per annum since then. In 1975, itamounted to only 12 percent of GDP in market prices. The domestic savingsrate has followed a similar trend.

vii. Agriculture dominates the economy: 85 percent of the populationlive in the rural areas, and agriculture presently contributes more than 40percent to GDP and 80 percent of export earnings. In contrast, manufacturingcontributes only 13 percent of GDP and mining less than one percent. Between1970 and 1974, agricultural output rose by 2.7 percent per annum with most ofthe growth taking place in 1974. The expansion of coffee and cotton productionin particular has been encouraging. However, the slow progress made inexpanding rice output, which has lagged behind the growth in population,is the most serious problem facing Madagascar. Large shortfalls in domesticrice production led to record rice imports in 1973 and 1974, at at total costof over US$50 million. Livestock production, too, has lagged with cattlenumbers actually declining over the past five years, resulting in a decreasein meat exports in 1973 and 1974.

viii. Between 1970 and 1974, manufacturing production grew by 3.3 percentannually in real terms. Owing to the drop in effective demand followinga poor harvest and the departure of many expatriates, a small decline wasrecorded in 1973, but there was a strong recovery in 1974. Output is mostlyprocessed agricultural products and consumer goods for the domestic market.However, for long term growth, Madagascar will need to develop exportindustries; in particular, there is potential for the further processingof raw materials. Political uncertainties since 1972 have resulted in asharp downturn in foreign private investment, such that by 1974 the netoutflow of direct investment income matched the new inflow of privatecapital. Medium and long term credit for manufacturing has fallen 30percent over the same period, which is also indicative of the drop inprivate sector investment in manufacturing.

ix. Despite world inflationary pressure, consumer prices rose byonly 6-7 percent annually between 1970 and 1973. Large increases in importprices, combined with a doubling in the price of rice, gave rise to a rateof inflation approaching 20 percent in 1974; since then, however, inflationhas greatly moderated. In an attempt to protect the living standards of theurban poor, the wages of the lower paid workers were raised approximately

- iii -

40 percent in 1974. Extensive price controls have successfully delayedthe passing OLL of increased wage costs to consumers. The net effect of

the Government's incomes, prices and tax policies has clearly been to improve

overall income distribution.

x. In the past the administration of public finance has been relativelyconservative, but the most recent budget indicates a determination to usepublic expenditure to boost development. In the period 1970 to 1974 CentralGovernment revenue grew much less than GDP, and expenditure both current andcapital actually declined in real terms after 1972. The current budgetarysurplus was reduced by more than 55 percent between 1971 and 1972, but there-after it grew steadily, financing more than one third of capital expenditurein the following three years. Since 1971 the Government has resorted to

increased internal short and medium term borrowing, but it was only in 1974,when the Treasury borrowed FMG 10 billion to finance emergency rice imports,that it reversed its traditional position of being a net depositor with thebanking system.

xi. The ratio of tax revenue to GDP has fallen from 15 percent in 1971to less than 12 in 1974, partly owing to the abolition of the cattle and polltaxes which were previously levied on the rural population. However, thecommissions now collected by the fokonolona on the sale of farm produce,although lower, have in part replaced local taxes as a source of revenue forvillage development. There is scope for increasing the tax effort, but onlygradually and after a thorough evaluation of various alternative tax measures.

xii. The investment budget has been substantially underspent recently,

particularly in 1974, indicating that problems have been encountered inproject implementation. Political uncertainties and frequent changes in

personnel have been partly responsible, but cost increases have also createddifficulties in the award of contracts. The 1976 budget provides for a levelof investment nearly double actual expenditure in 1975, but it remains to be

seen whether the capacity to implement development projects has expandedcorrespondingly. Current expenditure has also been substantially increased in1976 (22 percent); part of this increase is to enable the salaries of junior

employees to be raised. Of note, too, is a 41 percent increase in the budgetedexpenditure for education which is required to finance the proposed reform.Although revenue is estimated to grow by 17 percent in 1976, almost no current

budget surplus will be generated. However, the Government intends to useincome derived from state enterprises and part of the reserves of the cropstabilization funds to finance almost one third of the investment budget.

xiii. The banking system has undergone substantial changes in the past

three years. In July 1973, Madagascar left the Franc zone, replacing itscurrency board with an independent central bank. The opportunity has been

taken to direct credit to priority sectors and to give preference toMalagasy nationals. After stagnating in 1972 and 1973, credit to the

- iv -

private and parastatal sectors jumped 21 percent in 1974 mainly to enable theincreased cost of imports to be financed. Medium and long term credit tothese sectors have declined since 1972, reflecting the slack in privateinvestment.

xiv. Madagascar was faced in 1975 with a serious shortage of foreignexchange, principally owing to the sharp deterioration in the terms of trade.While the volume of merchandise exports grew by over 4 percent between 1972 and1974, the volume of imports was reduced no less than 28 percent by the imposi-tion of strict quantitative controls. As a result, the balance of paymentscurrent account showed a much reduced deficit in 1973. However, in 1974 theimport price index rose 63 percent while export prices rose only 34 percent,resulting in a FMG 12.5 billion (US$52 million) deficit in the current accountof the balance of payments. Net inflow of capital declined each year between1971 and 1974, the drop in private investment not being compensated fully bythe increase in public capital receipts. The external situation improvedlittle in 1975 and, by the end of the year, international reserves stood atonly US$36 million, the equivalent of five weeks of merchandise imports.However, in the first half of 1976 international reserves rose sharply,totalling almost US$67 million by mid-year.

xv. Madagascar's recent economic difficulties may be seen as theresult of adverse external trends, combined with the short term effectsof a major reorganization of the economy. Now the stage has been set fora concentrated effort to boost production so that the population may enjoysteadily improving living standards. The Charter provides a clear politicalframework; the task ahead is to elaborate in detail a plan which relatesprecise policies to the general objectives and specific projects to globaltargets. For this work greatly improved statistics are required. Particularattention needs to be given to strengthening agricultural planning, improvingthe management of state enterprises, boosting industrial investment andtraining skilled manpower.

xvi. The strengthening of agricultural planning should enable a moreeffective investment program to be formulated. There is considerable scopefor raising agricultural production, but without a detailed and well coordi-nated plan only slow progress may be expected. The main problems to beovercome include (i) poor roads, (ii) unsatisfactory marketing arrangements,(iii) an inadequate supply of farm equipment and inputs, and (iv) the lack ofcredit facilities for small farmers. At the same time, greater priceincentives could be offered, especially in those cases (e.g. meat and rice)where the producer price is below the import parity price. The expansionof rice production to enable Madagascar to feed itself is of paramountimportance. If present trends continue, the country's rice deficit couldreach 500,000 tons by 1990.

xvii. The expansion of state enterprise may have adverse consequencesfor economic growth unless satisfactory management is instituted. It isnoteworthy that where the state has progressively taken control of anestablished enterprise, the activities of the entity have usually continued

- v -

in a sound manner. However, where the state has attempted to set up atotally new organization, the results have been disappointing. The short-age of managers with relevant commercial experience has been a criticalconstraint. To achieve better management of parastatal organizations, itwill be necessary to improve the system of accounts and to develop proce-dures for internal communications so as to ensure greater coordinationbetween the different operating departments. The training of managers isof the highest priority.

xviii. If private investment in industry is to grow, steps will beneeded to clarify policy, particularly with regard to incentives andprofits, and to accelerate project preparation in those cases where thestate is a major participant. There are considerable opportunities forexpanding small-scale and artisanal industries, which could be aided bya package of services, including the supply of inputs, the marketing ofproducts and the provision of credit, backed by advice on productiontechniques and accounting methods.

xix. Madagascar is faced with a growing number of educated unemployed,yet at the same time there are acute shortages in certain categories ofskilled manpower. Out of a total population of some 9 million, growing at 3percent annually, approximately 4.4 million belong to the active labor force,of whom about half a million are in salaried employment. Over the next tenyears the active population will grow by one million, of whom less than onethird are likely to find salaried jobs. More particularly, given existingtrends it is unlikely that each year more than 20,000 will be placed in jobsrequiring a full primary education or more, yet the present output of thepost-primary educational establishments is already 17,500 per annum, and afurther 37,000 complete six years of primary education each year. Thus theeconomy's requirements for academically educated manpower would be satisfiedwithout any expansion of secondary education; the need is for increasedtechnical and vocational training carefully tailored to the demand for skilledworkers.

xx. To achieve sustained growth now requires a sharp increase in theinvestment rate. In the mission's view it would be feasible for Madagascarover the next decade to raise industrial production by 6 percent per annumand agricultural production by 3.5 percent per annum, giving an overallannual growth rate of 4 percent. This indeed would appear to be a minimumtarget if living standards are to improve perceptibly; nevertheless, itwould require a 50 percent increase in the investment rate by 1980.

xxi. The prospects for the balance of payments in the near term appearfavorable as a result of the projected improvement in world coffee prices.After 1980, the terms of trade are expected once again to move againstMadagascar, causing a widening resource gap. Assuming that exports grow atthe same rate as GDP, by 1985 Madagascar may require a net capital inflow ofUS$200-250 million, equivalent to approximately 30 percent of projectedinvestment.

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xxii. It may be concluded that, given conditions of stability whichpermit the consistent implementation of current policies, Madagascar has

good prospects of reversing the recent decline in per capita income and

achieving a steady improvement in living standards. The actual rate of

growth will depend primarily on the Government's ability to accelerate

public investment, improve the management of public enterprises, and provide

the labor force with relevant skills. It will also greatly depend on the

effectiveness of the fokonolona as an institution for promoting peasant

agricultural production.

MADAGASCAR

ECONOMIC MEMORANDUM ON THE

CURRENT ECONOMIC POSITION AND PROSPECTS

AND SELECTED DEVELOPMENT ISSUES

I. INTRODUCTION

Background

1. The present report was prepared by a mission which visited Mada-gascar in October/November 1975. It updates the economic report (No. 167a-MAG) distributed in July 1974. The latter was based on the findings ofa mission which visited Madagascar in October-November 1972, shortly afterGeneral Ramanantsoa replaced Philbert Tsiranana as President. In January 1975General Ramanantsoa resigned and Madagascar subsequently passed through aperiod of political uncertainty finally ending with the appointment of Com-mander Ratsiraka as President in June 1975. Reflecting the new politicalorientation of the Government, a major revision of internal and externalpolicies has been initiated, involving a fundamental restructuring of theeconomy. Consequently, substantial changes in the economic situation haveoccurred since 1972; these are discussed in the present report.

2. Madagascar gained independence in 1960, yet links with the for-mer colonial power remained very strong up to 1972. Within the Governmentheavy reliance was placed on French technical assistance personnel. Theprivate sector was dominated by French-owned firms and, as Madagascar was amember of the Franc Zone, France had considerable influence over monetarypolicy. After the change of Government in 1972 the Treaties of Cooperationwith France were substantially revised and many adjustments have been made.

3. Over the past four years, Madagascar has passed through atesting period and has emerged apparently strengthened. This is a majorachievement indicating a fundamental consensus in favor of national unity.A referendum held in December 1975 resulted in an overwhelming vote infavor of a new constitution based on a strong presidential system. The ref-erendum also confirmed Didier Ratsiraka as President. The Malagasy Republichas been renamed the Democratic Republic of Madagascar.

The Plan and the Charter

4. In 1973 President Ramanantsoa's Government published the NationalDevelopment Plan 1974-77, which outlined its development strategy and es-tablished production targets. The Plan envisaged a steady acceleration inthe rate of economic growth from 2 percent in 1974 to 5 percent in 1977 andcalled for a total investment, both public and private, of about US$750million (FMG 169 billion) over the Plan period. Two thirds of investment

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was to be financed from domestic resources, implying an exceptionally highlevel of domestic savings. The industrial sector was projected to growat 4.5 percent per annum and was to absorb one fifth of total investment,while agriculture was expected to grow by 3 percent, or 0.5 percent fasterthan the projected rate of growth of population. The Plan did not presentany detailed government budget projections, but it was stated that currentexpenditures would be increased at the same rate as GDP.

5. While many of the policies and objectives described in thePlan have been retained by the present Government, in a number of impor-tant respects the emphasis has changed. The basic political orientationof the new Administration has been set out by President Ratsiraka in theCharter of the Malagasy Socialist Revolution, published in September 1975.Both the Plan and the Charter proposed reforms aiming at:

(a) placing control of the economy in the hands of Malagasy;

(b) fostering local democracy; and

(c) promoting social justice.

The Charter, however, is more explicit than the Plan in its socialist orien-tation. Although it is not an economic plan, the Charter goes beyond broadprinciples to specify in certain instances a number of precise actions to betaken by the Government.

6. Control of the economy is to be achieved by a substantial increasein state enterprise. 1/ The Plan specifies a number of sectors which are tobe reserved to the State. To these the Charter adds a number of other sectorswhich the State will control through equity participation. In September 1975,the Government took over full ownership of the commercial banks, insurancecompanies and a number of key businesses on terms to be subsequently negotiated.It is intended that the State should become the majority shareholder in allenterprises of national importance. For certain activities the State has setup new state corporations; for example, the marketing of essential foodstuffs- rice, maize and groundnuts, in particular - is the responsibility of SINPA,2/while the distribution of certain imports and exports is undertaken by SONACO; 3/

1/ For details, see Annex III.

2/ Societ'e d'Interet National pour les Produits Agricoles.

3/ Societe Nationale du Commerce.

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both were made monopolies to enable the State to have full control overproducts considered vital to the economy. In future, rather than create newparastatal bodies, the Government intends to seek, where it deems necessary,either a majority or a minority share of the equity capital of foreign enter-prises through the medium of sectoral state holding companies. The Govern-ment's share will vary depending on the nature of each business. It is notintended that the State should intervene in day-to-day management, whichthe Government wishes to be based on sound business principles. Rather,through participation in meetings of the executive Boards, the Governmentwill guide overall policies to ensure they are consistent with nationalobjectives.

7. Inequalities in income and level of development between differentregions, compounded by an over-centralization of decision-making in Tanana-rive have been a source of discontent in the past. There is little dataon the distribution of income and wealth, but there is a striking contrastbetween conditions in the capital, Tananarive, and the rest of the countryand between the densely cultivated High Plateau and the arid South, wherethe population barely subsists. To correct this imbalance, the Governmentproposes, as far as practicable, to channel investment to the least favoredareas. The Charter also proposes that the regional administrations shouldbe greatly strengthened. As many government activities as practicable areto be devolved to the regions, which will be granted a large measure ofautonomy.

8. To foster local initiative a comprehensive reform of local gov-ernment was introduced in 1973. The Charter makes this reform a centralfeature of the policies of the present Government. The new system is animaginative adaption of the traditional village council (called "fokono-lona") which is being transformed into a democratic institution, gearedto development. The new system enables villagers to share in the decision-making process and thus participate actively in improving local conditions.The intention is to create a four-tier hierarchy of representative institu-tions roughly corresponding to the commune, canton, sub-prefecture and pre-fecture, with extensive powers and responsibilities. The fokonolona areexpected to engage directly in communal economic activities, such as thecollection and sale of crops to SINPA and other agencies, the retailing ofessential commodities and the channeling of credit. They are empowered tocollect levies on marketed produce and to use the proceeds to finance schoolsand other services. Fokonolona have been established throughout the country -some 10,000 in all - a large proportion of which has already begun developmentprojects such as the construction of roads, communal buildings and smallirrigation works. l/

1/ For details, see Annex I, pp. 5-7.

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9. The Charter expresses great concern that government action shouldbe directed towards minimizing inequalities among social groups. Theintention is to reduce gradually salary differentials. An important re-lated measure envisaged is land reform; large estates which remain unex-ploited are to be subdivided and distributed to small farmers, while farmsowned by absentee landlords are to be reallocated to the sharecroppers whoactually work the land.

10. In contrast to earlier policies which sought to promote develop-ment through large state-owned and mostly expatriate managed farms and ag-ricultural development corporations, the emphasis is now being placed onsmall projects which can be planned and implemented by Malagasy at the foko-nolona level. While the main unit of production is to be the individualpeasant farmer, stress is placed on the formation of socialist cooperativeswithin the framework of the fokonolona system, both for production and mar-keting. Fokonolona are also encouraged to establish communal plots.

11. Consistent with the Charter's policies of "democratization, decen-tralization and malagasization," the Government has embarked on a radicalreform of the educational system. All children of school age are to be en-rolled in a five-year program of basic education with a curriculum adaptedto the needs of each region. The Charter envisages doubling the enrollmentat the primary level by 1979 (this would involve putting an additional mil-lion children into school) and the training of some 18,000 national service-men as teachers. At the higher levels the curricula are to be made morerelevant to the circumstances of Madagascar and its regions. The schools anduniversity are to play a major role in the mobilization of the population insupport of the reforms described in the Charter.

1/II. PRODUCTION AND INCOME

Overall Growth

12. In the period immediately following Independence in 1960, theeconomy stagnated and GDP per capita declined slightly. In 1965 a recov-ery set in, and from then until 1971 GDP grew on average by almost 5 per-cent annually, while the investment rate reached almost 18 percent of GDP in1971. In this period, the economy was characterized by a high marginalsavings rate of 40 percent and a small resource gap. The comprehensivestructural reform of the economy which has been taking place since 1972 hasbeen accompanied inevitably by initial management problems. These, combinedwith the recession in the world economy, have had an adverse impact on overall

1/ In view of the limited availability of official statistics the Missionundertook extensive work to prepare the statistical tables presented inthis report from available primary data. However, owing to major defi-ciencies in the latter, figures quoted should be treated with caution.

economic performance. Real GDP in 1975 was only 3.6 percent above the level

reached in 1970. This small increase has been spread unevenly over time, with

GDP actually falling in 1972 and 1973, followed by a slow recovery in 1974 and

1975.

Table 1: GROWTH OF PRODUCTION AND INCOME

1970 1971 1972 1973 1974 1975

GDP m.p. (current prices, bill. FMG) 249 269 274 300 376 401

GDP m.p. (1970 prices, bill. FMG) 249 260 257 251 255 259

Income effect of changes in theterms of trade (bill. FMG) - -2 -2 -4 -12 -19

GDY (1970 prices, bill. FMG) 249 258 255 247 243 240

GDY per capita (1970 prices, US$) 118 119 114 107 102 98

Population (millions) 7.60 7.82 8.05 8.30 8.56 8.84

Source: Mission estimates (Annex V, Tables 2.2, 2.4, and 2.6.

13. GDP per capita in current prices rose from US$118 in 1970 to US$182

in 1974 (on a straight exchange rate conversion). However, measured in 1970

prices, it only reached US$107 in 1974. Moreover, the cumulative losses

arising from the adverse movement in the terms of trade amounted to approx-

imately US$72 million between 1970 and 1974 (in constant 1970 prices), with

the result that gross domestic income (GDY) in 1974 estimated in 1970 dollars

amounted to only US$102 per capita. Thus, over the period 1970-74 real per

capita income declined by an estimated 15 percent, and by a further 4 percent

in 1975.

14. Between 1970 and 1974, both agriculture and industry slightly grew

considerably faster than services and public administration. In current

prices, agriculture's share in GDP jumped from 30 percent in 1970 to 42 per-

cent in 1974; this is explained primarily by the doubling in the price of

rice. The service sector showed a small decline in value added after 1971,

mainly owing to a decline in the contribution of trade, reflecting the fall in

the volume of imports. The value added of the public administration sector

declined mainly owing to the sharp fall in the number of technical assistance

personnel from 1,454 in 1970 to about 600 in 1974.

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Table 2: SECTORAL COMPOSITION OF GDP(percentages)

1970 1974 1974 Real growth(1970 prices) (1970 prices) (1974 prices) 1970-74

Agriculture 29.6 32.3 41.8 +11.5

Mining 0.4 0.5 0.5 +40.0Manufacturing 13.2 14.7 13.3 +14.0Electricity and water 1.2 1.5 1.1 +34.5

Construction 3.7 3.4 2.9 - 5.4Transport and communications 7.0 7.5 6.5 + 9.8Trade 13.5 12.5 10.7 - 5.3

Banking and insurance 1.6 2.1 1.8 +31.7

Other services 11.0 10.5 7.5 -2.5Public administration /a 13.5 11.8 10.3 -11.0Import duties 5.3 3.2 3.5

100.0 100.0 100.0

/a Including defense.

Source: Mission estimates (Appendix V, Tables 2.1 and 2.2).

15. Agriculture dominates the Malagasy economy: 85 percent of thepopulation live in the rural areas, and agriculture contributes over 40 per-cent of total GDP and 80 percent of export earnings. In contrast, manufacturingcontributes only 13 percent of GDP and mining less than one percent. Rice,the staple food, accounts for about one third of the gross value of agricul-tural production and is mostly consumed on the farm. In addition to rice, themajor cash crops include coffee, sugar, vanilla and cloves, but there is alsoa wide variety of other crops. Animal husbandry is important, too, with anational herd estimated at 8 to 10 million head.

16. Between 1970 and 1974, agricultural output rose by 2.7 percent per

annum with most of the growth taking place in 1974. There are marked annualfluctuations in the production of specific crops due mainly to varying climaticconditions. The slow progress made in expanding rice output production isthe most serious problem facing Madagascar. 1/ The production of paddy, themain cereal, has lagged behind the growth in population. While Madagascar hadbeen a substantial net exporter of rice in the 1960s, the situation has beenreversed since 1970. Large shortfalls in domestic rice production led tolarge rice imports in 1973 and 1974, costing in total US$51 million in foreignexchange. The good harvest in 1974/5 sharply reduced the need for riceimports in 1975. Two notable successes in the agriculture sector recentlyhave been the expansion of coffee and cotton. The production of coffee,

1/ The constraints to agricultural development are discussed in detail in

Annex I.

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the main export crop, rose 40 percent between 1971 and 1974, following asimilar decline between 1966 and 1971; it is grown mostly by smallholders.Cotton production has increased by almost 80 percent since 1970, replacingimports and yielding a small surplus for export. Livestock production haslagged, with cattle numbers declining between 1970 and 1974, owing to theeffects of drought and disease. On the other hand, fishing is making anincreasingly important contribution both to production and to export earnings.

17. Since independence in 1960, manufacturing has made steady prog-ress, raising its contribution to GDP from about 5 percent to 13 percent in1974. Existing factories are almost entirely devoted to the processing ofagricultural products and the production of consumer goods for domestic use.As manufacturing has expanded, the imports of non-food consumer goods havedeclined as a percentage of total merchandise imports from 42 percent in 1960to 14 percent in 1974, while imports of raw materials and intermediate prod-ucts have increased. Over the past five years the real rate of growth inmanufacturing has slowed to an average of 2.5 percent per annum; a smalldecline was recorded in 1973 followed by a strong recovery in 1974 and renewedstagnation in 1975. In 1973 a poor agricultural harvest, combined with anexodus of expatriates, resulted in a drop in effective demand. Recently, as aresult of price controls in the face of rising costs, profits were severelysqueezed.

Uses of Resources

18. As domestic income in real terms declined between 1970 and 1974 (seepara. 13), total private consumption also declined in real terms after 1972.The level of real per capita private consumption in 1974 was 10 percent belowthe level of 1970. Public consumption also declined in real terms; whileinvestment rose sharply in 1971 and, after a severe decline in the followingyear, increased satisfactorily until 1974. Gross domestic fixed invest-ment, 1/ as a proportion of GDP in current prices, fell from 14.6 percent in1970 to 12.5 percent in 1974 and domestic savings fell from 14.5 percent to10.4 percent over the same period.

1/ Actual investment may be somewhat higher as the data probably under-estimate smallholder farm investment and the construction of traditionaldwellings.

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Table 3: USES OF RESOURCES

(in constant 1970 prices: billions of FMG)

p1970 1971 1972 1973 1974 1975

Origin of Resources

GDP 249 260 257 251 255 258

Net inflow of resources /a 3 13 8 7 10 5Losses from terms of trade - -2 -2 -4 -12 -19

Use of Resources

Private consumption 167 175 182 175 171 166

Public consumption 46 51 45 42 42 42Investment 39 46 35 37 40 37

Saving

Domestic 39 39 37 35 39National (excluding transfers) 28 28 27 28 33

p = provisional.

/a Resource gap (i.e., imports of goods and services in constantprices minus exports of goods and services deflated by the import

price index).

Source: Mission estimates (see Annex V, Tables 2.4, 2.6 and 2.7).

19. Data on the composition of fixed capital formation are veryfragmentary. Private fixed investment, measured in real terms, fell in the

period 1971-73, but began to rise again in 1974. Public investment stagnated

throughout the entire five-year period. These trends are also reflected in

the decline in value added of the construction sector from FMG 9.2 billion in1970 to 8.7 billion in 1974 in real terms. Political uncertainties over thepast three years have resulted in a sharp downturn in foreign private invest-ment; the net inflow, including profits reinvested, fell from FMG 7.6 billionin 1971 to FMG 2.6 billion in 1974. 1/ Nevertheless, for the same period the

inflow of private capital was 50 percent higher than the direct investment

income outflow, although in 1974 the outflow slightly exceeded the inflow.

1/ DAC data is contradictory (see Annex V, Tables 3.3, 3.4 and 3.8) but

the discrepancy remains unexplained.

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Prices

20. The evolution of internal prices over the past five years hasbeen largely determined by two factors, namely the increase in the prices ofimported goods and changes in the domestic price of rice. The FMG price ofimports jumped by 63 percent in 1974, more than triple the cumulative increaseoccurring in the three preceding years. This increase, which in dollar priceswas 12 percent higher than the average for the non-oil producing LDCs, wasmainly due to the preponderance of rice imports, which recorded a 100 percentprice increase in 1974, and the impact of the increase in the prices ofpetroleum and petroleum products.

21. In order to stimulate rice production, the producer price of paddywas doubled between 1972 and 1974. As a consequence the retail price ofrice also nearly doubled to FMG 65 per kilo in 1974, which was neverthelessFMG 28 lower than the average cost of imported rice (c.i.f. Tamatave) inthat year. 1/ Rice constitutes a major component of the household expend-itures of the majority of Malagasies. To protect the living standards oflow income urban families, statutory wage rates were raised approximately 40percent in March 1974 for the lower paid workers. Inevitably this has givenrise to new inflationary pressures throughout the economy, but in many instancesprice controls have at least delayed the passing on of increased wage coststo consumers. 2/

22. The success of the price control measures in protecting the liv-ing standards of the low income families may be seen in the movement in theofficial price indices, which relate to the cost of living of low and highincome households in Tananarive. After jumping 22 percent between 1973 and1974, mainly as a result of the increase in the retail price of rice, the lowincome index rose only 8 percent in the twelve month period after June 1974.The high income index, in contrast, rose only 11 percent between 1973 and1974, but the rising cost of imported consumer goods caused a 14 percentincrease between mid-1974 and mid-1975. In the period June 1975 to June 1976,the low income index rose by 5 percent and the high income index by 10 percent,indicating that the rate of inflation had moderated. Nonetheless there is oneconsequence of price controls which is not reflected in the official cost-of-living indices. Scarcities of certain key commodities have risen from time totime and have resulted in the development of a black market with pricesconsiderably above the official prices.

1/ For a fuller discussion of agricultural prices see Annex I, Section E.

2/ For a fuller discussion of price controls affecting industry see AnnexII.

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Table 4: COST OF LIVING INDICES IN TANANARIVE1974-76

(1970 = 100)

Low Income Households High Income Households

Year/Month General Food General Food

1974 January 129 139 120 128April 144 161 126 135

July 145 162 127 137October 150 163 131 144

1975 January 155 172 138 153April 154 169 141 157

July 156 169 146 158October 157 169 151 160

1976 January 159 172 154 164April 162 175 158 171July 165 177 160 172

Source: INSRE (see Annex V, Table 6.2).

23. The Mission calculated a variety of indices while estimating thenational accounts aggregates in constant prices. The overall deflator forGDP in market prices was estimated at 147 for 1974, taking 1970 as the baseyear, more than half of the increase being recorded in the last year. Theprice index for private consumption was estimated as having risen 64 pointsover the same period, while that for fixed investment increased by only 34points.

Table 5: SELECTED PRICE INDICES

(annual averages; 1970 = 100)p

1971 1972 1973 1974 1975

GDP deflator 103 106 119 147 155Private consumption 104 108 125 164 181Fixed investment 103 107 115 134 139Merchandise imports 103 106 118 193 193

CoL. High income urbanfamilies /a 106 113 115 L28 145

CoL. Low income urbanfamilies /a 105 111 118 144 156

CoL. Food (low income urbanfamilies) /a 105 112 122 159 170

p = provisional./a = Index covers Tananarive only.Source: Mission estimates.

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III. PUBLIC FINANCE

Overview

24. Between 1970 and 1972, public expenditure, both current and capital,increased in real terms and then declined in the following years. However,availability of finance does not appear to have been the most critical factorin explaining the low level of investment in the public sector in 1973 and1974. Each year there was substantial under-expenditure on the capital budgetindicating the existence of non-budgetary constraints to the implementationof development projects. Given the political uncertainties which existed, itis not surprising that public sector investment has slowed down. Furthermore,the rapid change in personnel inevitably has had a significant impact onproject implementation.

25. Between 1970 and 1971, Central Government revenues grew by 14 per-cent, only to drop by 5 percent in the following year. In contrast, currentexpenditure continued to rise steeply (by 11 percent) and in consequence theCentral Government current surplus available for investment was reduced bymore than 55 percent to only FMG 4.6 billion. Since then there has been agradual recovery; by 1974 the current budgetary surplus had grown toFMG 6.4 billion, still well below the level achieved in 1970. Since the levelof foreign aid remained essentially unchanged, the Government resorted toincreased internal short and medium term borrowing to finance its investmentprogram, particularly in 1972 and 1973.

TABLE 6: SUMMARY OF CENTRAL GOVERNMENT REVENUE AND EXPENDITURE

(in billions of FMG)/b

1970 1971 1972 1973 1974 1975

Current revenue 38.8 44.3 42.1 45.6 49.4 52.9Current expenditure 30.8 33.8 37.5 40.5 43.0 47.5Surplus 7.9 10.4 4.6 5.1 6.4 5.5Capital expenditure 11.0 12.8 16.0 14.5 13.3 13.1Overall deficit 3.1 1.4 11.4 9.4 6.9 7.6

Financing

Foreign borrowing 3.8 2.8 2.4 5.1 3.3 n.a.Domestic borrowing 0.7 -1.6 6.1 5.8 2.9 n.a.Others /a -1.5 0.2 2.9 -1.5 0.7 n.a.

/a Includes contributions from stabilization funds, deposits with theTreasury and changes in liquid assets.

lb Provisional.

Source: Ministry of Finance and Planning (see also Annex V, Tables 5.1and 5.2).

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26. It was not possible for the mission to obtain a comprehensive viewof the overall public finance situation, as detailed accounts of the var-ious governmental and parastatal entities were not available. Changes in thegovernment structure have complicated the picture. The provincial budgetswere merged with that of the Central Government at the beginning of 1973. Thebudgets of the Ports 1/, Posts and Telecommunications, the Radio and Tele-vision Network and the National Printing Office continue to be annexed to thecentral government budget, but the railways organization was separated in 1975and is now treated as a semi-autonomous public enterprise. A number ofparastatal bodies - the most important being the crop stabilization andpension funds - maintain accounts with the Treasury, but are in other respectsautonomous. A further complication is that the government budget records onlythose investments financed by domestic funds or loans, but not those paid forout of foreign grants. The latter were reported by the OECD's DevelopmentAssistance Committee as amounting to US$17 million (FMG 3.8 billion) in 1973and US$20 million (FMG 4.8 billion) in 1974. 2/ Lastly, the large ricesubsidy, which was provided in 1974, was financed by a Central Bank loan tothe Treasury. By the end of 1974 the debt outstanding arising from ricepurchasing operations, for which the Treasury must ultimately bear re-sponsibility, amounted to over FMG 9 billion (US$37 million), equivalent toapproximately one fifth of total tax revenue in that year.

Current Expenditure

27. In nominal terms current expenditures of the Central Governmenthave recently shown sustained growth, increasing on average at 9 percentper annum between 1970 and 1975, a rate comparable to the nominal growth inGDP (i.e. 10 percent p.a.). Partly as result of taking over the budgets ofthe provincial administrations and partly owing to salary increases, a growingproportion of the central government budget has been spent on wages andsalaries at the expense of expenditures on goods and services. Sinceexpenditure in real terms has hardly increased, there has been a decline inexpenditure on goods and services in real terms; this has had some adverseconsequences for development.

1/ The port of Tamatave was separated in mid-1972.

2/ It is possible that these figures contain some funds used for currentexpenditure.

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Table 7: LEVEL AND COMPOSITION OF CENTRAL GOVERNMENTCURRENT EXPENDITURE

/a1970 1975

Billions Billionsof FMG Percentage of FMG Percentage

Wages and salaries 15.4 50 29.2 61Goods and services 10.9 35 10.9 23Transfers and subsidies 3.2 10 6.1 13Public debt interest 1.3 /b 4 1.2 3

Total 30.8 100 47.4 100

/a Provisional figures.

/b Including some amortisation payments.

Source: Mission estimates (see Annex V, Table 9.1).

28. One serious aspect of the decline in real expenditure on goodsand services has been a reduced amount of road maintenance. Notwithstand-ing large investments made in expanding the road network, expenditure onroad maintenance fell by 25 percent in nominal terms between 1972 and 1975;in real terms the decline has been much greater. The funds made availablehave been insufficient to prevent the roads from deteriorating; eventually,the cost of rehabilitating them will probably be higher than the cumulativecost of carrying out normal maintenance.

29. The mission was unable to obtain information on actual governmentexpenditure by economic function for recent years. If data for 1973 arecompared to the budget estimates for 1975, it appears that a declining pro-portion of the budget is being allocated for economic services, and thatcurrent expenditure has shifted slowly in favor of social services. Thefall in the share of agriculture, public works and transport has been moremarked than in the case of other economic services. On the other hand, theproportion of expenditure devoted to general administration, defense andsecurity has increased in the past two years, in contrast to the sharp declineregistered between 1968 and 1973.

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/aTable 8: CENTRAL GOVERNMENT CURRENT EXPENDITURE:

COMPOSITION BY MAIN FUNCTIONS(in percent)

/b1968 1973 1975

Administration 34 24 26Economic services 24 26 23Social services 32 33 34Others 10 17 17

100 100 100

/a Includes provincial budgets.

/b Budget estimates.

Source: Ministry of Finance and Planning.

Current Revenue

30. During the period 1970-74, Central Government revenue grew moreslowly than GDP, the ratio of revenue to GDP falling from 16 to 13 per-cent. 1/ A major reason for this was the heavy reliance placed on customsduties, which in 1970 contributed 34 percent of total domestic revenue;the volume of imports declined markedly between 1970 and 1974, and particu-larly sever2 restrictions were placed on the more highly taxed luxury imports.Direct taxes grew more slowly than GDP - 25 percent (in nominal terms) ascompared to 51 percent - which may be partly explained by the decline incompany profits. The poor yield from these sources was to a great extentcompensated for by the revenue derived from consumption and value addedtaxes.

31. A major change in the fiscal structure in the period underreview was the abolition of the poll and cattle taxes which used to accrueto the provincial administrations. The principal reason for eliminatingthese taxes, which by reputation were closely associated with the colonialregime, was that their administration had given rise to abuses and injus-tice and that the taxes had become increasingly unpopular. In 1972, thefinal year the taxes were levied, their total yield amounted to FMG 5.7billion, equal to approximately 12 percent of tax revenues from allsources. Other modifications of the fiscal system have included: (i) ex-tending the pay-as-you-earn collection system to cover the entire countryin 1973, (ii) the introduction in 1974 of a uniform 10 percent value added

1/ If the cattle and poll taxes, which were collected by the ProvincialAdministrations, are added to central government revenuein 1970, the ratio of revenue to GDP is 18 percent.

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tax in place of a two-tier system under which luxury goods were taxed at12 percent and other goods at 5 percent, (iii) the steepening of the gen-eral income tax schedule with a maximum rate of 60 percent on incomes aboveFMG 5 million per annum, and (iv) the raising of consumption taxes on cer-tain goods (e.g., milk, sugar, wine). Efforts, too, are being made toreduce tax evasion, mainly by the creation of special tax brigades to makein-depth examinations of the affairs of selected tax-payers. The formationof tax brigades was one of the measures proposed in the National DevelopmentPlan 1974-77; other measures, yet to be implemented, included the restruc-turing of indirect taxes, the use of wealth indicators to assess high incomeearners, merging of the personal and profit tax for individual entrepreneursand the extension of fiscal monopolies to products other than tobacco.

Table 9: CENTRAL GOVERNMENT CURRENT REVENUE 1970-75(in billions of FMG)

/a1970 1971 1972 1973 1974 1975

Direct taxes 6.6 6.9 6.5 9.3 8.2 9.3Consumption taxes 4.9 5.8 5.6 6.1 6.4 6.6Value added taxes 6.8 7.7 7.2 7.4 8.9 10.2Import taxes and duties 11.2 13.7 12.3 11.1 12.1 14.4Export taxes and duties 2.1 2.4 2.4 2.9 3.1 5.5Other indirect taxes 4.1 5.0 4.5 4.0 5.7 2.9Non-tax revenue 3.3 2.8 3.7 4.9 4.9 4.1

Total 38.8 44.3 42.1 45.6 49.4 52.9

/a Provisional.

Source: Ministry of Finance and Planning.

32. The ratio of tax revenue to GDP, a measure of the tax effort of acountry, was 12 percent in 1974. This is comparable to other developingcountries, taking into account per capita income and the structure of theeconomy, although it is a little below the average for African countries.To achieve a higher tax effort careful tax planning would be required, basedon a thorough evaluation of the impact of various tax increases. For indirecttaxes, a study of price and income elasticities of particular goods is required.In particular, there would appear to be scope for increasing duties on luxuryimports; there are advantages, too, in relying on high duties rather thanon quantitative import controls to protect import substitution industries andto limit imports as a means of preserving foreign exchange.

33. With the abolition of the poll and cattle taxes, the tax burdenon the rural population has been much reduced. The imposition of producelevies by the fokonolona as a source of revenue for local developmentmay be regarded as a substitute, but the yield has been generally much

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lower. If the fokonolona are to make a significant contribution to thefinancing of local development, the levies will have to be increased. Thecontrol and management of these local funds presents a considerable admin-istrative problem.

Central Government Investment and its Financing

34. The level of central government capital investment reached a peak ofFMG 16 billion in 1972. Preliminary estimates for 1975 indicate that centralgovernment investment in that year was lower than in any of the previousthree years. The detailed breakdown by sector, data for which is availableonly for 1973 and 1974, indicates that transport receives the major share.Investment in education amounted to an exceptional FMG 900 million in 1974.

/aTable 10: CENTRAL GOVERNMENT INVESTMENT

1973-741973 1974 Percentage

(in billions of FMG)

Agriculture 4.8 4.8 34Transport 6.7 5.5 44Other 3.0 3.0 22

14.5 13.3 100

Total authorized expenditure: 17.7 21.0

/a Excludes investment financed by external grants.

Source: Ministry of Finance and Planning.

35. The annual investment budget has been underspent over the past threeyears. In 1973, 82 percent of authorized expenditure was spent; in 1974 thefigure was 63 percent. The size of the budget was reduced by 25 percent in1975, but substantial underexpenditure is nevertheless expected. One of thecauses has been delays in making funds available at the beginning of the year,complicated in 1973 by the introduction of a system of zero budgeting. 1/ Amore serious problem has been the slow pace of project preparation andimplementation. Rapid inflation has created special difficulties with con-tracts, when the bids received were much higher than foreseen.

1/ This system requires executive ministries to seek renewed authoriza-tions for all budget allocations relating to ongoing projects; theobjective is to deter departments from earmarking funds which theycannot in fact spend in the current year.

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36. Recently about half of all central government investment has beenfinanced by budgetary savings. This has only been possible because invest-ment has declined. As a percentage of GDP, central government investmenthas fallen from 4.5 percent in 1970 to 3.5 percent in 1974. Foreign bor-rowing has averaged about FMG 3.5 billion over the past five years, butwithout any clear upward trend. There was little recourse to domestic bor-rowing until 1972 when the fall in revenue led to a threefold increase inthe overall budget deficit. In that year the Government raised FMG 6 bil-lion by issuing government bonds, mainly short and medium term. Since 1972,there has been a decline in domestic borrowing. Other sources of financehave included surpluses derived from the annexed budgets and transfer fromthe crop stabilization funds.

The 1976 Budget

37. The 1976 Central Government budget provides for a 22 percentincrease in current expenditure and for an investment budget amounting toFMG 24.7 billion, or nearly double the actual expenditure in the precedingyear. Current budget receipts are projected at FMG 63 billion, approximatelybalancing recurrent expenditures. The investment budget is to be financed by(i) income from investments (FMG 4.0 billion), (ii) foreign and domesticborrowing (FMG 11.6 billion), (iii) contributions from the stabilization funds(FMG 3.2 billion) and (iv) use of Treasury assets to meet the balance. Theannexed budgets are balanced at FMG 9 billion, including provision of FMG 2billion for capital expenditure.

Table 11: GOVERNMENT BUDGET ESTIMATES, 1975 and 1976(in billions of FMG)

1975 1976

Central government current expenditure 51.2 62.6Central government current revenue 56.0 63.0Annexed budgets current expenditure 5.2 7.1Annexed budgets current revenue 9.1 9.2

Central government capital expenditure 15.6 24.7Annexed budgets capital expenditure 3.9 2.1

Total capital expenditure 19.5 26.8

To be financed by:

(i) Central government currentbudget surplus 4.8 0.4

(ii) Annexed budget current surplus 3.9 2.1(iii) Investment income and stabilization

funds - 7.2(iv) Net borrowing 9.6 9.6(v) Use of treasury assets, and

other treasury operations -0.6 7.5(vi) Central Bank advances 2.0 -

Total 19.5 26.8

Source: Ministry of Finance and Planning.

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38. Part of the increase in current expenditure is explained by asubstantial rise in the minimum wages of the lowest paid government em-ployees announced in January 1976. The cost of this wage rise is esti-mated at FMG 3 billion, equivalent to 5 percent of current revenue. Ofnote, too, is the increase in the budgeted expenditure for education whichhas been raised 41 percent to FMG 15.5 billion, and now amounts to 25 per-cent of the total current budget expenditure.

39. The projected increase in current revenue amounts to 17 percentover the provisional estimate for 1975. To assist in reaching this target,customs duties have been raised on a range of goods, the most notable beingimports from the EEC. A considerable increase in customs duty revenueis foreseen as a result of a higher volume of imports. A special effortis envisaged to collect tax arrears. The achievement of the revenue targetwill greatly depend on the actual growth of dutiable imports; yet, at thesame time, the development of the economy would suggest that this categoryof imports should continue to be limited so that foreign exchange might bereserved to finance investment and intermediate goods. The large estimatefor investment income from state enterprises is a new item.

IV. MONEY, CREDIT AND THE BALANCE OF PAYMENTS

Money and Credit

40. The banking system has undergone substantial changes over thepast three years. In July, 1973 Madagascar left the Franc zone, replacingthe Currency Board by an independent Central Bank. This has given the Gov-ernment the opportunity to exercise greater flexibility in the management ofmonetary matters. In particular, steps have been taken to direct credit topriority sectors and for preference to be given to Malagasy nationals. Thiswas achieved by instituting a system of prior authorization by the CentralBank for all loans and advances to firms having total outstanding credit inexcess of FMG 100 million. To encourage the commercial banks to lend toMalagasy nationals, the Central Bank discounts without prior approval, follow-ing a simplified procedure, short and medium term credit of less than FMG 5million extended to citizens for production and professional purposes.

41. Following the establishment of the Central Bank, the Governmentacquired a majority share in the equity of two of the four commercial banks.In June 1975, all commercial banks were nationalized and considerationis being given to reorganizing the banking sector to create a more rationaland efficient system. 1/

1/ See Annex III, Section IIB.

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42. After growing 11 percent in 1971, credit advanced to the privateand parastatal sectors stagnated in the two following years, only to jump by21 percent in 1974 and to fall off again in 1975. Deflated by the GDP priceindex, the level of private credit at the end of 1974 stood 9 percent belowthe level attained at the end of 1970. The expansion of credit in 1974 wasnecessary in order to finance both the increased cost of imports in generaland of imported rice in particular, in addition to the expansion in theproduction of cash crops which took place D-. that year.

Table 12: ASSETS AND LIABILITIES OF THE BANKING SYSTEM(in billi;,rs o- FMG; end of year)

1970 1971 1972 1973 1974 1975

Assets

Credit to the private sector 53 60 59 60 70 72Net credit to Government -8 -9 -3 -4 5 /a 13Net foreign assets 17 16 19 22 19 12

Total 61 67 76 77 94 97

Liabilities

Money 46 47 53 57 67 68Quasi-money 9 12 12 11 14 14Other liabilities 6 8 11 10 13 15

/a This does not include credit for the importation of rice.

Source: Central Bank and IMF (see also Annex V, Table 6.1).

43. The massive rice imports of 1973/74 resulted indirectly in a sub-stantial increase in Central Bank advances to the Central Government; creditto SONACO and SINPA, guaranteed by the Central Government, amounted to as muchas FMG 9 billion at the end of 1974. 1/ As a consequence, during 1975 theGovernment's borrowing from the Central Bank remained at the statutory ceiling,which is fixed at 20 percent of domestic revenue. Thus, between 1970 and 1975the Government shifted from being a substantial net creditor to the bankingsystem to being a substantial net debtor. This change in position was notsimply the result of mobilizing domestic resources for development; rather itwas largely a consequence of the large rice consumer subsidy, aimed primarilyat protecting over a limited period low income families from the impact of theexceptionally high price of imported rice.

1/ The advance made by the Central Bank to cover the rice subsidy wasconverted into a 25 year loan in 1976.

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44. Credit to the agriculture sector grew markedly in 1974, reflect-ing the good harvest. Although the commercial banks provide some credit forthe marketing of agricultural products, the National Development Bank (BNM) isthe principal source of agricultural credit. In 1974 no less than 98 percentof BNM's lending in the agricultural sector was in the form of marketingcredit provided to the parastatals and to private companies. Very littleagricultural credit reached the small farmers, since the BNM to date hasrestricted its credit to organized farmers. In view of the emphasis now beinggiven to rural development, the question of smallholder credit is receivingmuch greater attention. BNM makes available approximately 50,000 loansannually to small farmers and is currently operating accounts with 2,000fokonolona. For the future it is envisaged that BNM will provide group creditto the fokonolona, which will be responsible for making individual loans tofarmers and will act as guarantors.

Table 13: DISTRIBUTION OF CREDIT BY SECTOR(in billions of FMG)

1970 1971 1972 1973 1974 1975

Agriculture 9.0 9.7 10.2 10.4 15.4 13.3Commerce 14.7 15.0 13.9 15.0 18.0 15.6Mining & manufacturing 19.5 23.9 24.5 21.7 24.1 26.5Other 3.3 3.1 4.2 4.2 4.7 3.8

Source: Central Bank (see Annex V, Table 6.2).

45. Medium and long term credit to the private sector has declinedover the past three years, reflecting the lack of growth in investment.Agriculture has received an increasing proportion of this type of credit,whereas the share of manufacturing has fallen from 54 percent in 1970 to 48percent in 1975, with an estimated drop of 40 percent in real terms. Thiscorresponds to the sharp fall in private sector investment in manufacturing.

Table 14: DISTRIBUTION OF CREDIT BY TYPE(in billions of FMG)

1970 1971 1972 1973 1974 1975

Short term 36.3 39.4 39.0 38.6 50.1 48.7Medium and long term 10.2 12.3 13.8 12.7 12.0 10.4

of which:agriculture 1.4 1.3 1.8 2.0 1.9 1.7manufacturing 5.5 7.7 8.1 6.7 6.0 5.1

Total 46.5 51.6 52.8 51.3 62.1 59.1

Source: Central Bank (see Annex V, Table 6.2).

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46. The banking system is mainly concerned at present to satisfy shortterm requirements of the economy. The question for the future is whether ahigher rate of investment will find adequate support from the banking sys-tem. This may require the commercial banks to allocate a greater proportionof their credit as long term loans. Furthermore, a favorable agriculturalseason accompanied by a larger investment effort will automatically call fora substantial expansion of credit, and at this point public and private sec-tors may come into competition, giving rise to a need for careful planningof credit creation to ensure that adequate credit is channeled into highpriority sectors.

47. The nationalization of the commercial banks raises the specificissue of the desirable relationship between the state-owned banking systemand state corporations. In similar circumstances in some other countries,where both the banks and the state corporations are public enterprises, thebanks on occasion have been led to finance various potentially unviableoperations of state corporations, thereby allowing the enterprises to build uplarge debts. The Central Bank may be expected to make efforts to hold thecommercial banks to the principles of sound lending policy, but decisionsconcerning state corporations which encounter financial difficulties are oftentaken elsewhere within the Government for obvious reasons of overall nationalpolicy. A nationalized banking system, under these circumstances, couldbecome a means of channeling additional subsidies in a disguised form.Provided the banks continue to be required to operate as commercial entities,autonomous in their day-to-day operations, they would be more likely to resistpressure for lending to state corporations for loss-making ventures, thusprecipitating remedial measures when serious financial problems confront astate corporation. A related issue is the possible role of the commercialbanks in financing investment requirements of state enterprises through shortterm credit. Such practices may provide a state enterprise with the financialresources to make investment decisions which are not necessarily in accordancewith government priorities.

Balance of Payments

48. At the end of 1975 Madagascar was faced with a serious foreign ex-change constraint, principally owing to the sharp deterioration in the termsof trade. The volume of exports has grown in recent years in step with GDPand, in current value terms, somewhat slower. The volume of imports on theother hand fell 39 percent between 1971 and 1974; however, import pricesincreased by 93 percent during the same period. The current account of thebalance of payments showed a small deficit in 1970. In the following yearexpenditure on merchandise imports (f.o.b.) rose 24 percent which was notmatched by an increase in export earnings; consequently the current accountdeficit more than tripled to FMG 15 million (US$56 million). Tight importcontrols practically eliminated the trade deficit in 1972 and led to aFMG 6 billion (US$28 million) trade surplus in the next year. Despiteexceptionally large rice imports amounting to FMG 9 billion (US$38 million) in1974, Madagascar nevertheless managed to balance its trade (f.o.b.). However,net non-factor service imports have grown considerably, especially as a

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result of the decline in the exports of "other government services." 1/

The current account deficit reached FMG 12.5 billion (US$52 million) in 1974,

and is estimated to have grown further in 1975. By December 1975, inter-

national reserves stood at only US$36 million, equivalent to some five weeks

of merchandise imports. Owing partly to much improved coffee prices, inter-national reserves rose sharply in the first half of 1976, reaching US$61million in August.

Table 15: BALANCE OF PAYMENTS SUMMARY(in billions FMG)

1970 1971 1972 1973 1974

Exports f.o.b. 40.1 40.7 41.8 44.5 58.0Imports f.o.b. -39.5 -49.1 -42.4 -38.3 -58.2Trade balance 0.6 -8.3 -0.6 6.3 - 0.2Net non-factor services -3.4 -5.6 -7.6 -13.9 -14.5Net factor services -10.3 -10.8 -10.1 -6.5 -7.2Net current transfers 8.8 9.3 9.2 7.4 9.4

Current account balance -4.3 -15.5 -9.1 -6.8 -12.5

Net private capital inflows 4.6 7.1 5.3 3.1 1.8Net public capital inflows 7.1 8.3 8.1 7.5 8.0Errors and omissions -1.7 -1.3 -1.8 -0.3 -Monetary movements -1.7 2.1 -1.8 -1.2 -5.9Allocation of SDRs 0.9 0.8 0.8 - -

Changes in internationalreserves /a +4.9 +1.5 +1.6 +2.4 -8.7

/a Negative sign indicates decrease.

Source: Mission estimates (see Annex V, Tables 3.2, 3.3 and 3.4.

49. Madagascar has a great variety of exports, mostly agriculturalproducts, the principal items being coffee, vanilla and cloves. In 1974,these contributed over 41 percent of total export earnings. In volume terms,

coffee exports have grown impressively, reaching 65,381 tons in 1974, 26percent higher than in 1970. A part of the exports in 1973 and 1974 repre-sented the disposal of stocks after the expiry of the International Coffee

Agreement. 1974 was an unusually good year for vanilla, with exports at

a record level. In contrast, exports of sugar were unusually low at a time of

high world prices, partly because Madagascar withdrew from the OCAM SugarAgreement, and thus ceased to export to the Ivory Coast which had previously

been a major outlet, and partly because sales were delayed in anticipationof even higher prices. In fact, prices fell in 1975 and stocks were soldbelow peak prices. Over the period 1970 to 1974, sugar exports declined

1/ This relates mainly to the removal of French bases, which resulted in

a sharp decline in the export of government services.

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as internal consumption has grown and production stagnated. Exports oflivestock products have also shown a downward trend after 1972 for similarreasons. The most important new export item is seafood, mainly crustaceans,which increased almost six-fold in tonnage shipped between 1970 and 1974, andnow contributes over 6 percent by value of total merchandise exports. Other

than processed agricultural products, Madagascar exports as yet virtually nomanufactured goods.

Table 16: TRENDS IN PRINCIPAL EXPORT COMMODITIES(in billions of FMG)

Total Percentage ofpercentage total exportgrowth earnings in

1970 1974 in constant prices 1974

Total exports f.o.b. 40.2 58.5 + 6 100of which:

Coffee 10.9 15.6 +26 27Vanilla 3.6 4.5 +11 8Cloves 4.7 4.0 -4 7Meat and meat products 2.5 4.3 +10 7Sisal 0.7 2.5 - 1 4Sugar 1.5 1.7 -73 3Rice 3.1 1.1 -83 2Seafood 0.8 3.5 +224 6Minerals 1.9 2.9 +24 5

Source: INSRE and Mission estimates (see Annex V, Tables 3.9, 3.10 and 3.11).

50. The decline of imports in real terms in the period 1970 to 1974was particularly marked in the case of capital goods which fell by 40 percent.Imports of transport equipment, for example, fell 50 percent. The FMG importprice index for crude petroleum leapt 320 points between 1970 and 1974. Themost significant addition to imports in this period was rice; while in thepast (except in 1965) Madagascar had been a net exporter of rice, the situationwas reversed after 1970 with net imports rising to a peak of 92,864 tons in1974. During this period the FMG price of rice increased no less than 228percent. In 1973/74 the net foreign exchange cost of rice imports, allowingfor the profitable export of de luxe rice, amounted to FMG 10.5 billion (US$44million), which was more than Madagascar's total international reserves at theend of 1975.

51. To correct the trade imbalance, Madagascar has severely curtailedimports. Despite the rise in international prices, the total value of Mada-gascar's imports of non-food consumer goods in 1974 was nearly 20 percentlower than in 1971. The decline has been primarily in tobacco products, soapand cosmetics, and in textile goods, with local production largely replacingimports. Imports of beverages, dairy products and processed foods have alsobeen greatly curtailed, partly as a result of increased domestic production,

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and partly because demand has also fallen as a result of the departure of alarge section of the expatriate community.

Table 17: TRENDS IN SELECTED IMPORTS(in billions of FMG)

PercentageTotal of total

percentage merchandisegrowth in imports in

1970 1974 real terms 1974

Total imports c.i.f. 47.3 67.3 -26 100Food and beverages 4.9 12.6 -2 19(of which: rice) (0.7) (9.3) +422 (14)Other consumer goods 8.8 9.4 n.a. 14Crude petroleum 2.4 10.8 +6 16Capital goods 12.9 11.5 -40 17

Source: INSRE and Mission estimates.

52. The overall result of the price trends mentioned above has beena sharp deterioration in Madagascar's terms of trade, which has greatlyreduced the country's capacity to import. Indications are that this ad-verse trend continued into 1975. However, improving coffee prices towardsthe end of 1975 have started to reverse the downward trend; a substan-tial improvement in the terms of trade is expected in 1976 and 1977.

Table 18: FOREIGN TRADE INDICES(1970 = 100)

/a1971 1972 1973 1974 1975

Export volume 102 102 105 106 138Export prices (FMG) 99 102 106 137 128Import prices (FMG) 103 106 118 193 193Exports as "capacity to import"

(volume) 98 98 94 75 91Terms of trade 96 96 90 71 66Import prices (US$) 104 117 148 223 250Import prices for all LDCs (US$)/b 103 111 138 201 215

/a Provisional estimates.

/b Excluding oil exporters.

Source: IMF and Mission estimates.

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53. To date France has been by far the most significant trading part-ner, buying over one third of Madagascar's exports and providing approxi-mately one third of merchandise imports in 1974; in 1965, these percentageswere 45 and 63, respectively. The USA has become increasingly important,especially as a market for vanilla. Following the recent changes in foreignpolicy, great efforts have been made to diversify export markets and sourcesof supply, and it may be expected that France's dominance in trade willfurther diminish in the future. If this occurs, the Government will need toreview the present policy of linking the exchange rate to the French franc.As it is, the revaluation of the franc in relation to the dollar, whichoccured in 1975, had an adverse impact, tilting internal prices in favor ofthe consumer of imported goods to the disadvantage of the producers of exports,whose real earnings have already suffered as a result of the unfavorablemovement in the terms of trade. The weakening of the French franc during1976, however, has more than offset the exchange rate movements that tookplace in 1975.

54. Despite the departure of many French technical assistance per-sonnel after 1972, technical assistance grants increased between 1970 and1974. However, there was a decline in workers' remittances after 1972 andin the import of luxury goods typically consumed by expatriates. France'scancellation of debts amounting to FMG 6.8 billion in 1972 appears in thebalance of payments accounts as a large increase in capital grants in thatyear and there is an offsetting item under loan repayments. There was adecline in the net inflow of capital in 1972, 1973 and 1974; the fall indirect private investment has not yet been compensated by an increase inpublic capital receipts.

55. Despite the overall deterioration in the balance of paymentssituation in 1974 and 1975, Madagascar has not had recourse to the con-siderable credit available through the various facilities of the IMF.Thus, although Madagascar's payments position became critical towards theend of 1975, it had by no means exhausted its actual and potential for-eign exchange resources. As short term prospects on balance are favor-able, it would appear that foreign exchange will be much less of a con-straint to development than in the recent past. Nonetheless, since im-ports have been heavily curtailed over the past two years, it must be ex-pected that the volume of certain categories of imports will now be rapidlyexpanded. This is particularly true for spare parts for machinery whichhave been in very scarce supply.

V. MAIN ISSUES

56. The Government has taken determined steps to reform the institu-tional structure of the economy. The foremost consideration motivatingGovernment actions has been rapid malagasization. Special attention hasalso been given to measures which reduce social and regional inequalities.Progress towards these objectives has been impressive. Now the stage hasbeen set for a concentrated effort to boost production so that the popula-tion may enjoy a steadily improving standard